Monday, 30 November 2015

Corbyn’s election: Rational economics starts here

The following piece was originally a presentation to the recent conference of the Labour Assembly Against Austerity. Prof. Chick is one of the foremost Keynesian economists in Britain. 

The argument below may surprise many who regard themselves as ‘Keynesians’ and yet who argue for persistent budget deficits and routinely borrowing to support consumption.

On the contrary, a key point of agreement between Marxists, genuine Keynesians and others, and one that is reflected in the editorial line of SEB, is that investment is decisive for economic growth and that the current crisis is caused by the weakness of investment.


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By Victoria Chick

Since the election of Jeremy Corbyn as leader it has become acceptable in the Labour party to challenge the austerity doctrine (Corbyn The Economy in 2020). What a welcome change! Rational economics starts here.

I shall take it as read that everyone in this room holds the following truths to be self-evident:

(1) That austerity is counterproductive if its purpose is to reduce the public debt and 

(2) That its real purpose is to provide a smoke-screen behind which to shrink the state and reward the rich

There is another truth that is less obvious:

That government cannot determine the size of its deficit by its own actions. 

Austerity is not only unpleasant politics; it is bad economics. We need to explain and communicate this fact to the electorate -to demonstrate that we are not the ones who are economically illiterate!

The economics of austerity is based on an inappropriate generalisation from the individual’s budget to the government’s budget. Mr Micawber can control his deficit, but only because he is a small cog in a great machine. Government is a big component of the machine, and other parts react to what it does. Those reactions influence national income, the level of unemployment (and hence benefits) and tax revenue. A cut in expenditure will reduce income by more than the original change in government expenditure (the multiplier, working negatively).

Second, there is the ‘three balances’ identity: (G-T) + (I-S) = M-X
[where G is total Government spending, T is Government revenues, I is investment, S is savings, M is imports and X is exports].

The private sector is just about in balance; the fiscal deficit is almost the mirror image of the international current account deficit. The fiscal deficit cannot be eliminated (should you want to) without eliminating also the international deficit, which almost no-one is talking about (John Mills is an exception).

Alternatives to austerity 

If you really want to eliminate the deficit, the positive response of the economy to government action, the multiplier in the positive direction, needs to be enlisted. In a recent blog, the TUC’s senior economist, Geoff Tily, recalled that Keynes, who was the first to exploit the potential of the multiplier, did not use the phrase ‘deficit spending’ which is so closely associated with his name but rather ‘loan expenditure’. Now since deficits have to be financed by borrowing you might not see any distinction, but the point is that wise, productive loan expenditure pays for itself over time and increases the productivity of the economy. Output and employment rise, the tax take rises, benefit costs fall and we have increased our productive and social capital. Loan expenditure reduces the deficit as the economy recovers. The point is rhetorical, but it is good rhetoric that we need.

Keynes on the budget

Let us look more closely at Keynes’s view of budgetary policy, for it is usually much mis-represented and current discussion of the budget in normal times is still somewhat confused. He distinguished between the ‘ordinary budget’ or current account, and the capital budget or spending ‘below the line’ – a distinction we make today.. The latter was to be used to compensate for failings in private-sector investment. 

‘...periods of deficiency (sic) expenditure should be made the occasion of capital development until our economy is much more saturated with capital goods than it is at present.’ (J M Keynes, Collected Writings vol XXVII p 320)

This would by itself make the economy more stable:

‘...if the bulk of investment is under public or semi-public control and we go in for a stable long-term programme, serious fluctuations are enormously less likely to occur.’ Ibid. p 326

By contrast the aim should be for the current budget normally to run a surplus,  

‘which should be transferred to the capital Budget, thus gradually replacing dead-weight debt with productive or semi-productive debt...’ ibid. p 277

‘I should not aim at attempting to compensate cyclical fluctuations by means of the ordinary Budget. I should leave this to the capital Budget.’ Ibid p 278

The two budgets serve different purposes:

‘[T]he capital budgeting is a method of maintaining equilibrium; the deficit budgeting is a means to attempt to cure disequilibrium if and when it occurs.’ Ibid, pp 352-3

And capital expenditure ‘has nothing whatever to do with deficit financing’ ibid. p 352 

In other words, deficit financing is for emergencies only – emergencies like the depth of a depression. That lesson was learned and applied after the financial crisis. There is no need to follow the financial crisis with a self-inflicted fiscal crisis. The economy is currently far from peachy but it is not in dire straits. Let us not plunge it into further recession by austerity. Worse, this and the previous government have gone about things in precisely the wrong way, cutting investment rather than current expenditure. Let us instead keep calm and debate where the capital budget should be directed. Intelligent capital spending is more likely to reduce the deficit than austerity.

What kind of capital spending?

As anyone who has read Michael Meacher’s last book knows, there is no shortage of useful things to do. Everyone will have his or her priorities here; but there are some very obvious candidates: green infrastructure, housing. In general, real investment, including investment in those things whose return is hard to measure (education, health, even some infrastructure), and even in things that yield little or no financial return. On this latter point, there is a tremendous PR job to be done, for the mindset is as wrong-headed today as it was in Keynes’s time. He wrote:

‘The nineteenth century carried to extravagant lengths the criterion of what one can call for short "the financial results," as a test of the advisability of any course of action sponsored by private or by collective action. The whole conduct of life was made into a sort of parody of an accountant's nightmare. … I spend my time … in trying to persuade my countrymen that the nation as a whole will assuredly be richer if unemployed men and machines are used to build much needed houses than if they are supported in idleness. … 

The same rule of self-destructive financial calculation governs every walk of life. We destroy the beauty of the countryside because the unappropriated splendours of nature have no economic value. We are capable of shutting off the sun and the stars because they do not pay a dividend.’ ‘National self-sufficiency’, The Yale Review, Vol. 22, no. 4 (June 1933), pp. 755-769_

We must face down that dreadful sneer, that government is no good at ‘picking winners’. Is the private sector so good at ‘picking winners’? The banks, for example? Private investment now has virtually dried up, in favour of at best unproductive and at worst pernicious financial speculation. The incentives for private share-holder-owned companies in any case favour far too short a time horizon. As Mariana Mazzucato argues, government’s role is to create and foster markets, not just to rectify their malfunction. That means a courageous state must not flinch; it must be prepared to ‘pick’ what in its best judgement will be winners but knowing that some will be losers – to use the power of its budget to change the direction of our economy to deal with the pressing problems that we face. The private sector will not do that. It wants to return to business as usual. Business as usual is not an option.

2 comments:

Stephen Stretton said...


There's something important missing, which potentially deserves a very brief mention. That effect is the economic incidence of government spending - who benefits in the long term?

If increases in land value caused by infrastructure investment are not captured, then it's possible that these investments will simply make rich landowners richer in the long term.

Take HS2. If we ignore the inadequacies of the scheme and replace it with a good one, then presumably it should go ahead. But if it is paid for out of general taxation and there is no general land value tax, then apart from the workers who are the involved in constructing it, the general benefits will go to those people who already own property.

There's a better way: http://www.independent.co.uk/travel/news-and-advice/hs2-alternative-high-speed-rail-network-could-be-20bn-cheaper-and-pay-for-itself-a6761946.html

We've seen this in Cambridge - the link to London was improved and house prices have gone up massively in the last few years. Same in Bristol - 20 minutes will be cut from the journey time and house prices are expected to rise 5-10% across Bristol. http://www.knightfrank.co.uk/resources/residential/insights/bristol/bristol-rail-report.pdf

The 'loan' mentioned in the article can be paid back.

It's most obvious with transport infrastructure but also I believe true more generally with infrastructure (e.g. fibre optics).

This effect has not been obvious between around 1918 and 1979 because although there wasn't Land Value Tax we had policies (domestic and non-domestic rates - a much more progressive system than council tax - institutional controls on property lending, capital controls, rent controls, house building, social housing) that, essentially together had together the same sort of effect as a land value tax: http://www.if.org.uk/archives/5393/housing-crisis-what-housing-crisis

Unless some of the 'value' created by the state is captured in an LVT or a specific levy on those that benefit, then the main benefit of improved infrastructure (in high density countries with restrictive planning law) will go to the already wealthy or comfortable. The more efficient and the greater the investment the more the long term benefit to the already wealthy.

Gary Dymski said...

Bravo, Vicky! A voice of reason in a time of increasing incoherence.